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Trading Ideas: The Resistance/Support Exchange

Posted July 14, 2011

Topics: Finance & Investing

When a current trading range is replaced with a new one -- meaning price levels move above resistance or below support, and remain there, new resistance and support levels are set. But one interesting outcome that traders will notice is the exchange of the old lines for new lines. Old resistance may become new support or old support become new resistance once the new trading range has been set.

This happens often enough to give you some insight about the orderly tendency of price trends. Even in a chaotic market, you can find some rare moments of predictable behavior. Resistance and support are the foundation of order within the technical world of price movement. This does not mean that markets are efficient; it does mean that some rules do apply.

Assume that old resistance will become support (or old support will become new resistance) as a starting point. For many traders, breakout means breakdown, with established trading range in chaos and no predictable means for knowing when price moves too rapidly or too far, or whether a new range will be set or price will turn and go back to previous levels. But if you draw a straight line through the old barrier, even when the breadth was dynamic, you can look for a pattern. You often will find one.

What happens if price later tests the new support level but does not violate it? This means the new support should be treated as a new and permanent (for the moment at least) support level. If this occurs, you can have confidence that there is something to the flip theory. (The same is true in the other direction, testing resistance.)

The rule is likely to apply when resistance and support and not strictly horizontal. Many stock trading ranges maintain the same breadth in price while moving upward or downward over time. In these cases, the trendline may remain the same even while rising support or falling resistance flips and replaces the old limits with new ones.

You still need to confirm an apparent breakout and new trading range before making any trades based on what appears to be going on. Rely on technical patterns, volume, and candlestick formations to confirm what support and resistance flips appear to tell you. The tendency for these levels to exchange is valuable information, but it only works if you use it within a confirmation policy.

No technical system is foolproof. The best you can hope for is an improvement in timing of entry and exit based on observation of these kinds of technical patterns. The resistance/support exchange is one more piece of the technical puzzle and awareness adds to your knowledge when a breakout takes place.

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five  courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.”  He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to the CBOE blog and to the Seeking Alpha blog.